Backdoor IRAs for Retirement Savings

green plant beside white wooden door
by Advice Chaser
by Advice Chaser
green plant beside white wooden door

It has a slightly shady name, but rest assured, a backdoor IRA is a perfectly legal way to save for retirement. If you’re looking to supercharge your retirement through your own funding efforts but you make too much money to contribute to a Roth IRA, this could be an excellent option for you. 

What is a backdoor IRA?

In short terms, a backdoor IRA isn’t actually its own kind of account. It’s simply a tax-deferred retirement account converted into a Roth IRA. You can convert traditional IRAs, 401(k)s, and 403(b)s into a Roth IRA using this backdoor method, although it’s most common to convert a traditional IRA. With a 401(k) or a normal IRA, you contribute money to your account and the amount is tax-deferred, which means that you pay taxes on it when you withdraw it. A Roth IRA is a similar account, but your contributions are post-tax and the money grows tax-free. Both types have pros and cons. If you have a traditional IRA and have decided that a Roth IRA is now better for your finances, you can make the conversion into a backdoor IRA. 

How do you set up a backdoor IRA?

Remember, a backdoor IRA is more of a process than a specific type of account. Here’s how you can set up the process. 

  1. First, of course, you must have an IRA set up. All the contributions you’ve made to your account must be non-tax-deductible. 
  2. The second step is to identify all trustees who will be involved. If you want to roll over your traditional IRA into a Roth IRA with the same provider, the process could be very simple with a same-trustee transfer. If your brokerage does not offer this service, things might be more complex. You may need to choose a different service that offers Roth IRAs and do a trustee-to-trustee transfer between the two.
  3. Convert the money immediately into a Roth IRA. If you wait, your taxes could get significantly more complicated and you may have to pay capital gains tax on any money you make from your investments in the in-between period. You’ll need to fill out Form 8606 on your taxes

How do you know if a backdoor IRA is right for you?

Like all other retirement plans, a backdoor IRA will be a good fit for some people and a not-so-great fit for others. Here are some things to consider to know if a backdoor IRA will be a profitable choice, or if it will cost you more taxes than it’s worth. 

One major advantage of this type of process is that there are no limits on how much you can roll over into a backdoor IRA. Roth IRAs have income limits and traditional IRAs have contribution limits, but a backdoor IRA is essentially the best of both worlds. When you convert your account into a backdoor IRA, you can roll over as much (or as little) as you want. A backdoor IRA is also an attractive option because it has no required minimum distributions, which means you can keep your money in your account for as long as you want. 

However, before you jump into the process, you’ll need to consider taxes. Your original IRA has received all its contributions pre-tax, so you’ll have to pay a big chunk of taxes on any money you roll over to a Roth. Another consideration is your retirement timing. According to the IRS, your backdoor Roth will need to be at least 5 years old before you withdraw from it, or else you could face a 10% penalty. 

Help with retirement savings

To know if a backdoor IRA is a smart move for your financial future, talk with a financial advisor. Your financial advisor will understand the tax implications, and he or she can also help you make the most of your retirement contributions. To find an advisor who’s a great match for you, schedule a consultation today. 

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